Bitcoin Arbitrage Explained – Is It Legal and Profitable?

August 24, 2021

As cryptocurrency is gaining more and more mainstream acceptance each day, traders are constantly looking for newer ways of taking advantage of the shift to virtual finance. One trend that is emerging, as a result, is Bitcoin Arbitrage.

If you are not new to the crypto world, you’ve probably heard the term being spoken about, often touted as a risk-free way of making profits from trading cryptocurrencies. But what exactly is arbitrage trading and what factors should you consider when trying to execute the strategy?

Before we move on, please check our guide on the best bitcoin arbitrage bots.

What you'll learn 👉

What Is Bitcoin Arbitrage Trading?

To break it down, Bitcoin arbitrage is really about leveraging crypto prices to your advantage. You see, at the moment, there are over 500 crypto exchanges in the market, and each one has different prices set on their cryptocurrencies.

Well, a crypto arbitrage is where a trader can take advantage of the price differences in the various exchanges. For example, they can buy Bitcoin from one exchange then immediately selling it on another at a profit.

Bitcoin arbitrage trading is quite a difficult technique. This is mainly because the crypto market fluctuates often. You never really know when the prices might spike upwards or dropdown. To actually yield profits, you’ll need to be constantly analyzing the patterns in the charts, and use them to predict future trends.

The trades also have to be made instantly to earn decent profits. If the market fluctuates before you sell your Bitcoin, you might end up making huge losses.

How Profitable Is Bitcoin Arbitrage

Bitcoin arbitrage can be quite profitable to a smart trader. However, you have to hone the skills and have the tools to spot opportunities in the market and capitalize on the trade. For example, there might be a $5 difference in the price of one Bitcoin on two different cryptocurrency exchanges.

If you buy 10 Bitcoins from the cheaper exchange and sell on the more expensive one, you can make up to $50 every day. If you do the same repeatedly each day, you can make thousands of dollars every week.

However, it is vital that you first have the knowledge to perform these transactions. You have to be quick and persistent in taking action on potentially profitable opportunities as they come. In some cases, you might find that the spread is bigger, in which case, you stand to make higher profits.

Also, the above example is only one strategy, called spatial arbitrage (where you buy crypto from one exchange and sell it to another), however, you have the option of combining it with other arbitrage strategies and earn even greater profits.

The major risk is in the period between the time you purchase the Bitcoin and when the transaction is validated by miners. During this time the market might make a sudden shift, for or against your favor.

If the price drops in the exchange you intend to sell it on, you won’t receive the expected profits. Also, some exchanges require you to pay a certain amount of trading fees, which might cut down your expected profits as well.

Where to Look For Arbitrage Opportunities

When crypto was still new, most trades were done manually. Because of this, it was easier for price fluctuations to go unnoticed. However, as technology advanced, more computerized means were introduced to trading.

Price fluctuations have since become easier to monitor, thus eliminating price-errors. In turn, this lowered chances of sporting arbitrage opportunities. However, there are still a few tricks you can use to spot such opportunities.

For starters, you’ll need to keep watch of multiple listings at the same time to notice any differences across the different exchanges. Basically, if the buying price on one exchange is lower than the selling price on another exchange for Bitcoin, this is an arbitrage opportunity.

Luckily, there is arbitrage software and tools you can use for this. You can use a crypto arbitrage bot to buy and sell Bitcoins fast across multiple exchanges. A good example is automating buy BTC. You’ll only need to program your bot accordingly to do the arbitrage.

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Is Cryptocurrency Arbitrage Legal

Yes, cryptocurrency arbitrage is absolutely legal. Just like any other trade, it is all about exploiting price gaps that you spot on different platforms. Each exchange will have its own rate on its cryptocurrencies. This price will mostly be the same across most exchanges, however, due to inefficiencies; sometimes there is a deviation, usually about 3-10% ( although it can go as high as 20%).

Arbitrage in itself is a trading technique that has been around for hundreds of years. It is only now that people are realizing its potential in crypto. Since the cryptocurrency market is extremely volatile, there are more arbitrage opportunities experienced than in other markets.

But the catch is that the market can be influenced by the number of traders doing the exchange. As more traders do the arbitrage, they tend to nullify the difference in price, making it harder for other traders to make profits. You can say, the process of arbitrage itself eventually leads to the stabilizing of the market, while increasing trade volumes on the respective exchanges.

What Kinds Of Arbitrage Opportunities Exist In Crypto?

The most common arbitrage is called spatial arbitrage, or triangular arbitrage. It is where you take advantage of the difference in prices by buying your cryptocurrency one exchange and selling it on another. You stand to gain profit if you sell the crypto in an exchange where it sells at a higher price than you bought it.

For example, if exchange A is selling its Bitcoin at 5, 500 and exchange B sets its price at 5,750. If you buy it from A and sell it at B, you stand to gain $250. And since there are so many exchanges out there, and cryptocurrency is so decentralized, such opportunities can happen quite frequently.

The downside is that the market is extremely volatile. These opportunities can vanish as quickly as they appear. But then again such erratic changes often result in new ones popping up as a result, therefore, bringing on new opportunities. If you do it correctly, you can make quite a tidy sum within a small period of time.

Other than spatial arbitrage, there are two other arbitrage methods you can use.

Cross-border arbitrage- this approach is not so different from spatial arbitrage, only, in this case, the two exchanges are located in different countries. It can also consist of three different exchanges which all offer different prices. The strategy is difficult to execute because it is only possible because most traders in the highly-priced countries are unable to access the market rate themselves.

Statistical arbitrage – this is a more high-tech strategy involving mathematical modeling. It is risky because things tend to change really quickly within a short time span. It involves the use of trading algorithms, which capitalize on discrepancies in price that only exist within a really brief period of time.

Crypto/Crypto Arbitrage

Just like any other currency, crypto usually gains value depending on the scale of involvement. It is influenced by factors such as the demand by users, the coins scarcity, and utility. Bitcoin, for example, has the highest value, because you can count on it to maintain its value without depreciating over time.

crypto arbitrage on the other hand involves purchasing the coin on one market and instantaneously selling it on another exchange platform at a higher price. Therefore, rather than wait for the crypto to earn value over time, you gain profits from it at the moment by taking advantage of price discrepancies in the market.

Crypto/Fiat Arbitrage

Although uncommon, it is possible to explore arbitrage opportunities using fiat currencies in the same exchange or among different exchanges. Some exchanges like Bitfinex, Bitstamp, and Kraken allow trading in EUR and US against the Bitcoin at the same time. The main constraint is that Bitcoin takes a lot of time to verify a transaction. Also, the daily trade volume of BTC is relatively low, thereby minimizing the potentially attainable profits.

Strategies To Exploit Bitcoin Arbitrage

Use tools to discover opportunities- As we saw, to really stand a chance in Bitcoin arbitrage, you have to constantly have an eye at multiple listings at the same time. Doing this manually is all near impossible. Instead, there are various software and tools you can use to find opportunities.

These tools keep watch over the major currencies and highlight for you any discrepancies. This way you can take advantage of only the ones with the greatest margins. Some popular instruments include Coingapp, Coinarbitrage.org, Crypto arbitrage app, Tokenspread.com, and Arbitrage.expert.

Decide which opportunities are worth it – before you jump into the trade, there are a few factors you’ll need to consider to determine if the opportunity is actually profitable. You’ll need to check three things:

The estimate fees– this includes the transaction, network, deposit, transfer, and wallet costs

The risks involved – you need to check the market volatility, withdrawal and transfer periods, rules and restrictions for the withdrawals and exchange trades

Finally, don’t forget to check how much of the profits are taxable.

A good hack is to sign up, verify and fund different accounts on multiple exchanges before looking for the arbitrage opportunity. This will save you time when doing the trades.

Arbitrage automation – some software out there allows you to automate bots that scan for exchanges and then generate profits on their own. The bots run 24/7 so if you set up a strategy that works for you, you can have it execute even as you sleep. Of course, this comes with its fair share of risks, so only go for it and bet on money you can afford to lose.

Additionally, you have to do the trade as quickly as possible. Remember, the market can fluctuate within a matter of minutes. If you can, make larger trades while combining different arbitrage methods. This will yield you more profits at a time.

Tips and Pitfalls Of Crypto Arbitrage

KYC restrictions – usually to trade on crypto exchanges, you have to comply with KYC regulations in place. for example, in some cases, you have to have a bank account in the country where the exchange is based. Other times you have to first link your bank account and then verify your identity. Verifying the account with KYC might take up to 24 hours before you can actively trade.

Fees – most exchanges will usually have a deposit, withdrawal, or trading fees in place. This can be taken as a certain percentage of the money you are trading. Therefore, as you estimate your profits, you should factor in all these fees.

Withdrawal limits – This mostly applies to larger trades. Most exchanges will have withdrawal limits in place, meaning you can’t withdraw the whole balance from your crypto wallet all at once, or on the same day even.

Timing – You have to factor in the time it takes for the transaction to be verified by miners. This can take from 10 minutes to 30. Keep in mind that within this waiting period, the market might move against your favor, thereby losing the arbitrage profit. In some cases, the profit might even turn to a loss when the coins become cheaper on the other exchange.

Slower transactions – as trading volumes continue to surge across global crypto markets, the transactions take longer to be verified. This can be an issue if you are looking to make a quick transfer. Bitcoin in particular takes much longer to process when compared to other less popular coins like Ethereum.

Competition – if many other traders are looking to take advantage of the same arbitrage opportunity at once, it might cause changes in trading volumes on the exchanges. In turn, this reduces arbitrage opportunities for the traders who come later.

Avoid transferring BTC – Bitcoin transfers are often discouraged when doing arbitrage. They are notoriously known to take a lot of time to verify. And since arbitrage needs to be executed as fast as possible, Bitcoin transactions might hinder your chances of making profitable trades. Instead, consider other coins like Ethereum, whose transactions are much quicker.

Keep monitoring the market – Arbitrage opportunities are unpredictable and untimely. They can come up at any time. For this reason, need to be on the constant lookout to spot one. you stand a higher chance of profits when the market is most volatile. Check on any recent news or developments that might trigger such changes.

Diversify – The difference between prices will often be really small between popular exchanges. And if you only trade with 2 or 3 exchanges, it can be hard to spot any profitable arbitrage opportunities. For best results, try and spread out your trades to multiple different exchanges.

Limit losses – The rule of thumb with arbitrage is that you either trade really quickly or don’t trade at all. The market is quite volatile and at times the risks are greater than the rewards. Therefore, if you cannot execute a transaction fast on a particular arbitrage opportunity, you should let it go.

Hedge strategies – Hedging strategies are kind of like insurance policies which safeguard you from apparent damages. They are most recommended when there are likely to be sudden market changes. However, the downside is that these strategies also reduce the profits you’ll make. So, keep that in mind.

FAQs

How is an arbitrage opportunity calculated – when calculating an arbitrage opportunity, you are basically trying to determine the potential profits you can make. Usually, it is the difference in prices between the bid price on one exchange and the asking price of another. The higher the margin, the more profitable the arbitrage opportunity.

How to make money with crypto arbitrage – start by scanning many different cryptocurrency exchanges, checking for their prices on the same crypto. Then buy crypto from the exchange offering the lowest price, transfer it to the exchange selling their crypto at the highest price and then sell it there at a profit.

How to calculate costs and profits of crypto arbitrage – to calculate potential profits, you’ll have to factor in any fees involved in the transaction. Therefore take into account any withdrawal, transaction, taker, and marker fees at the purchase exchange and the deposit fees, take and marker fees, and cashing out fees at the selling exchange. And then add all those figures up. Also, consider the market volatility and taxes incurred. To get your potential profit, subtract the total figure from the potential profits you’ll gain from the buying and selling prices margin.

How to select exchanges for crypto arbitrage- there’s no definitive way of selecting the perfect exchange for crypto arbitrage. Usually, you go where the opportunity is. You can do this by scanning many different exchanges and identifying the one with the highest selling price and another with the lowest selling price of the same crypto, then trading between the two. To make the process easier, you can use various crypto arbitrage trading software or bots which do the scan for you.

What is an example of arbitrage – consider two crypto exchanges, exchange A and exchange B, both of which list a cryptocurrency like Bitcoin. Exchange A sets the price of Bitcoin at $5,000. Exchange B sets the price of Bitcoin is higher at $5,100. If you buy from A and sell at B, you stand to make a profit of $100 per Bitcoin. This is what we call an arbitrage opportunity.

Is arbitrage risk-free – Most fund houses will promote arbitrage funds as being risk-free. This is because you make profits, by simply buying from one exchange at a cheaper price and immediately selling it for profits at another exchange where the price of the crypto is higher. The short time period involved makes it so that no major investment is involved.

However, in reality, there is a certain level of risk involved. With the crypto market being as volatile as it is, the price can drop down within a really short time. And if it falls below the price you bought it at, before you make the trade, you can end up making losses.

Takeaway

There are a couple of arbitrage techniques one can benefit from. But as you’ve seen the opportunities are quite short-lived. As more and more traders engage in one opportunity, it gradually starts to disappear. The market is eventually stabilized and the price might end up leveling up to other exchanges.

Therefore, if you are looking to dive into the venture, you have to move extremely quickly. Trading in Bitcoin can be especially risky because it takes a longer time to validate a transaction. For this reason, you might want to consider other cryptocurrency options like Ethereum (ETH), which is almost just as reputable.